An important part of planning for health care expenses in retirement is building an inflation rate into the projections. Because health care comprises a large and growing portion of most retirees' budgets, people need to have an idea of what these costs will be so they can arrange to have the necessary funds available -- preferably before they retire.
The problem is, there is no way to forecast any one individual's future health care expenses. We can look at inflation projections by the Congressional Budget Office (http://www.cbo.gov/sites/default/files/cbofiles/attachments/44521-LTBO2013_0.pdf) or the Medicare Trustees (http://downloads.cms.gov/files/TR2013.pdf), but these two entities are looking at how much they will be spending on health care. The metrics are different for individuals, where health insurance covers most of the bills. What matters to individuals, then, is how much they will pay in health insurance premiums plus a smattering of out-of-pocket costs for services not covered by Medicare. (Long-term care, which is more than a smattering, is not included in this discussion.) While there is a connection between overall health care costs and the premiums individuals will pay to Medicare and private insurers, it is not direct. In fact, the inflation rate for your clients may be worse.
Premiums paid by Medicare enrollees must cover 25% of Part B and D costs. There is no cap on this figure. Plus, the hospital (Part A) trust fund is running out – it is due to exhaust in 2026 – which means those Part B and D premiums will have to pick up some of the slack (along with transfers from the general Treasury, which will raise the budget deficit).
The costs are not spread equally among all Medicare beneficiaries. Higher-income people pay more. And thanks to the Affordable Care Act's freezing of the income tiers for the income-related monthly adjustment – and the possibility that the income tiers could be lowered, a proposal that's already been made – clients who never expected to pay those Part B and D premium surcharges will end up paying them.
The Medicare Trustees estimate that the Part B and Part D growth rates will be 6.3% and 9.3%, respectively, over the next five years (see page 7 of the Medicare Trustees report). These estimates incorporate the cost reductions arising from the Affordable Care Act as well as the higher physician payments granted by Congress. If your clients' own inflation rates exceed these rates because of the income-related monthly adjustment being slapped upon them, well, you can see that the use of some "normal" type of inflation rate such as 3% or 4% won't cut it. And we haven't even considered where Medigap and Medicare Advantage premiums might go under these circumstances.
According to the Congressional Budget Office (page 29), total national spending on health care services and supplies increased from 4.6 percent of GDP in calendar year 1960 to 9.5 percent in 1985 and to 16.4 percent in 2011, the most recent year for which such data are available. Most people have been somewhat insulated from this runaway inflation in health care costs because their employers have picked up most of the tab. This is starting to change as employer plans shift toward high deductibles and higher copayments. Medicare beneficiaries have been hit with higher and higher premiums over the years, but because they started out so low – the Part B premium was just $3 in 1966 – the cost increases have been manageable.
Here's what I fear: employees who retire and give up their employer subsidies will not be prepared for the high and rising costs of Medicare and supplemental insurance premiums once they are responsible for these costs on their own. And retirees on fixed incomes will, at some point, suffer under the strain of higher premiums that they never expected to face when they retired. Medicare premiums, which are directly deducted from Social Security payments, are taking an ever larger cut out of Social Security benefits. Don't let articles on cooler health care inflation lull your clients into complacency about the very serious reality of high and rising health insurance premiums.
Given all the scary projections, I'm afraid that whatever inflation rate you use for your Retirement Healthcare Expense Analyses (a tool available to our Savvy Medicare members), it could turn out to be too low, especially if clients get hit with the Part B premium surcharge. But I also understand that if you use a realistic rate, the numbers might scare your clients away from serious planning. Use your own judgment there. But do impress upon them the need to plan ahead for higher health care costs.
Elaine Floyd, CFP®, is director of retirement and life planning for Horsesmouth and the author of Savvy Medicare Planning for Boomers, an advisor training program designed to help advisors prepare for health care costs in retirement. More information can be found at http://www.horsesmouth.com/medicare.
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